Tài liệu Dividend Stocks For Dummies Part 4 docx

Part IV
Checking Out
Dividend Investment
Vehicles
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In this part . . .
B
uying shares in a company is sort of like buying
cereal. You can purchase one big box of a particular
cereal or an assortment. In the world of investing, you
have even more options — dividend reinvestment plans
(DRIPs), direct purchase programs (DPPs), mutual funds,
exchange-traded funds (ETFs), and foreign dividend funds,
to name the most popular of the lot.
Don’t let the acronyms and investor jargon scare you off.
In this part, I explain each of these options in turn, and in
plain English; discuss their pros and cons; and show you
how to implement them in your dividend investment
strategy.
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Chapter 14
Compounding Your Returns with
Dividend Reinvestment Plans
In This Chapter
▶ Tuning in to the DRIP strategy
▶ Exploring the pros and cons of investing through DRIPs
▶ Signing up for a DRIP
▶ Keeping detailed records for tax purposes
▶ Digging up specific information about available DRIPs
D
rip, drip, drip . . . Water from a leaky faucet may not seem like much,

but at the end of the year, it’s likely to account for more than 30 gal-
lons. Likewise, dividends reinvested in a company through a DRIP or DRP
(dividend reinvestment plan) can form a surprisingly large pool of invest-
ment capital over time. As your shares earn dividends, you pour them back
into your investment to buy more shares, which earn more dividends to buy
even more shares to earn even bigger dividends — well, you get the idea. If
you drip some additional investment capital into the mix, your pool fills even
faster.
Companies that offer DRIPs usually run the programs themselves or through
an affordable transfer agent and often charge no or minimal transaction fees.
In addition, they may even offer a discount so that investors enrolled in the
program can pick up shares for less than the current market rate and rein-
vest dividends without incurring transaction fees. All these benefits and more
encourage investors to leave their money in a company for the long haul and
continue to invest even more, which is usually good for both the company
and the investors.
In this chapter, I bring you up to speed on DRIPs and other direct investing
strategies, such as direct stock purchase plans (DSPs). I explain their many
advantages, tell you how to enroll in a DRIP, and explain how to calculate
your cost basis to take into account the different prices you paid for shares
when reinvesting your dividends.
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Part IV: Checking Out Dividend Investment Vehicles
Understanding the Nature
of DRIPs and DIPs
A DRIP is one type of direct investment plan (DIP). Instead of buying shares on
the stock market, you purchase shares directly from the company on a regu-
lar basis. Dividends automatically go toward purchasing additional shares,
and in many plans you can buy additional shares outside of the dividend-

funded purchase, either as a one-time purchase or on a regular basis.
If you need some of that dividend money, many plans offer the option of rein-
vesting only a portion of your dividends and letting you take the remaining
dividends as cash.
Investing through DRIPs is old school — the way investing was intended to
be. When you invest through a DRIP, you and the company make a long-term
commitment to one another. Every dollar you invest and reinvest is a vote of
confidence in the company and its management. To earn your vote, the com-
pany is motivated to remain profitable and grow, and with money from you
and other investors, it has the capital to do just that.
Don’t let the fact that a company has a DRIP or a DIP be the reason you invest
in it. Research the company’s fundamentals first, as I explain in Chapter 8.
Only after identifying companies you want to invest in should you concern
yourself with whether the companies offer DRIPs or DIPs.
Recognizing the many names for DIPs
When DRIPs were created more than a half century ago, the main criteria
for joining the plan was that you needed to already be a shareholder in the
company. Sometimes this rule required owning as little as one share, but you
had to buy it through a stockbroker, and all you could do was reinvest the
dividends.
As DRIPs became popular in the 1960s, some of these plans evolved to allow
investors to purchase their initial shares directly from the company, cutting
out the middleman (the broker) entirely. These other plans go under a vari-
ety of names, but they all refer to essentially the same thing:
✓ Direct purchase plans (DPPs)
✓ Direct stock purchase plans (DSPs)
✓ Direct enrollment stock purchase plans (DESPs)
✓ No-load stock purchase plans
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Chapter 14: Compounding Your Returns with Dividend Reinvestment Plans
Understanding the difference
between DRIPs and DSPs
DRIPs and DSPs are kissin’ cousins, not identical twins. Both DRIPs and DSPs
allow you to reinvest dividends and purchase additional shares of stock. The
big difference between the two is that DRIPs still mandate buying your first
share through a stockbroker and then enrolling in the plan by submitting
an application and the stock certificate. DSPs allow you to enroll in the plan
when you buy your first share of stock.
At first glance, DSPs seem like the better deal: hassle-free, without the restric-
tions imposed on DRIPs. However, DRIPs comprise most of the low- or no-fee
plans, whereas many DSPs carry significant fees and even commissions. For
more about costs, head to “Looking Out for Fees” later in this chapter.
Managing the plans
Companies vary in how they administer their direct investment plans. Some
administer the plans themselves, whereas others work through a transfer agent:
✓ Company: Some companies have the internal resources to manage their
own DRIPs. You may not need to enroll in a DRIP to buy company stock,
but you do have to enroll to have your dividends reinvested.
✓ Transfer agent: A transfer agent is a financial institution that special-
izes in recordkeeping for entities with many small investors, such as
publicly-traded companies and mutual funds. Transfer agents record
every transaction in the account — deposits and withdrawals. They also
produce and send investor mailings and issue stock certificates.
Tracing the roots of DRIPs
Companies originally established DRIPs to
enable their employees to invest in the com-
pany through stock purchase plans. These
companies soon realized that they could

expand the program to investors, and because
the plans were already in place, they could
cost-effectively handle the expansion.
Companies knew that if investors reinvested
their dividends, the companies could sell new
shares and raise new capital without having to
go through the lengthy and expensive regula-
tory process of a full-blown secondary stock
offering. They could sell shares directly to
investors for less cost than having to hire an
investment bank to underwrite the new shares.
Companies with large capital needs, such as
utilities, financials, and real estate companies,
realized this strategy was so advantageous to
them that they encouraged investors to reinvest
(continued)
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Part IV: Checking Out Dividend Investment Vehicles
Weighing the Pros and Cons of DRIPs
Prior to investing in anything, examine the potential advantages and draw-
backs so that you know what you’re getting yourself into before you get into
it. With DRIPs, the advantages tend to carry more weight than the disadvan-
tages for long-term dividend investors, but they make little sense for inves-
tors who have a high turnover in their portfolios or need to keep their assets
more liquid. The following sections explain why.
Perusing the potential advantages
For dividend stock investors who are looking to build wealth over the long
haul, few (if any) investment programs can compete with the many advan-
tages DRIPs offer. The following sections reveal and explain the many ben-

efits. Hopefully, after reading through this long list, you’ll decide PDQ that
DRIPs are A-OK!
Getting started on a shoestring budget
DRIPs are very similar to mutual funds in that they’re good for investors
starting out with very little capital. With a minimal investment, you can pur-
chase stock in small quantities with low or no fees.
The one big difference is that mutual funds provide you with a portfolio
that’s diversified to some degree. With DRIP purchases, you own the stock
of just one company. Sure, you can diversify your portfolio by enrolling in a
number of DRIPs, but it’s more costly and complicated than buying mutual
fund shares.
One major benefit of DRIPs over mutual funds is that with DRIPs, you don’t get
stuck paying another investor’s tax bill. As I explain in Chapter 20, you have
to be careful about your timing when you’re buying mutual funds so that you
don’t end up paying taxes on profits that someone else collected.
their dividends by offering discounts of as much
as 5 percent off the share price.
The only rule was that participants were
required to own at least one share of the com-
pany’s stock to participate in the program. This
rule is still in place for many DRIPs today to
restrict participation to employees and inves-
tors who are serious about making a long-term
commitment to the company. Some DRIPs may
waive this rule and let investors buy shares
through a direct enrollment plan.
(continued)
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Chapter 14: Compounding Your Returns with Dividend Reinvestment Plans
Investing at your own pace
Although all DRIPs require a minimum investment to join the plan, you gen-
erally have the luxury of investing at your own pace. On top of reinvesting
dividends on a regular schedule, these plans offer you the ability to buy more
shares through the plan, often with no commissions. This enables you to
make additional investments — regularly or only when you have some extra
money to invest.
Here’s what you can expect:
✓ For most plans, the minimum investment can be as little as a single
share.
✓ Some DPPs have a minimum investment requirement between $250 and
$1,000.
✓ You may be able to buy additional shares commission-free through
optional cash purchase plans (OCPs). Many of these plans allow you to
invest as little as $10 at a time, although most set the minimum between
$25 and $50 with a maximum close to $10,000. Check the fee structure
before investing.
Some companies may even let you set up automatic debits from your bank
account to purchase shares on a regular basis. This setup is a perfect way
to take advantage of dollar cost averaging (which I cover in Chapter 18) and
follow the old rule of personal financial management — pay yourself first.
Saving on broker commissions
DRIPs eliminate the middleman (the broker who charges a commission to
process every transaction) because you purchase stock directly from the
company that issues it, saving you a ton of money in transaction costs.
Compared to a mutual fund, you avoid the load charged every time you make
an investment and the hefty management fees deducted from the fund’s
assets.
The less you shell out in broker commissions, the more money you have to

invest.
When the plan reinvests your dividends, you may save even more. In addi-
tion to charging no transaction fee, about 100 companies offer a discount on
shares purchased with the dividend reinvestment — typically from 1 to 10
percent of the current market price.
If you purchase stock through a brokerage, it may also allow you to reinvest
your dividends at no cost, but this arrangement isn’t a bona-fide DRIP. These
programs lack one main advantage DRIPs — they don’t allow you to purchase
additional shares directly through the company. As a result, you have to pay
a commission to buy additional shares. Ouch!
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Part IV: Checking Out Dividend Investment Vehicles
Taking the emotion out of stock investing
Investing can get emotional. When the market is going well, euphoria drives
Wall Street into a buying frenzy, with investors screaming “Buy! Buy! Buy!” In
the midst of dramatic economic downturns, fear drives the herd. Those same
investors who were once yelling “Buy! Buy! Buy!” are now frantically trying to
“Sell! Sell! Sell!”
When you buy a DRIP and commit to investing on a regular schedule, the
market’s movements have little effect on how you invest. In good times and
bad, you calmly and coolly acquire shares, building wealth slowly and more
surely.
Compounding growth one drip at a time
In Chapter 3, I tell the story of two investors — Party Pete and Frugal Frank,
who each own 100 shares of ABC Inc. at $20 per share. Party Pete spends
all of his dividends as he receives them, while Frugal Frank reinvests his by
purchasing more shares. At the end of three years, Party Pete sees a total
return on his investment of $1,100, while Frugal Frank cashes out a profit of
$1,327 — 21 percent higher than the party guy! Investing in a DRIP basically

turns you into a Frugal Frank automatically. You don’t receive a dividend
check tempting you to cash it out and fly to Aruba or use it to pay bills. Every
penny in dividends is automatically reinvested for you to purchase additional
shares of the company. These additional shares produce dividends, too.
By allowing the dividends to be reinvested, you tap into the power of com-
pounding growth without ever having to think about it.
Purchasing fractional ownership
When you purchase stock through a broker, you can’t buy a half or a third of
a share. With most DRIPs, as with mutual funds, you can. Suppose you earn
$100 in dividends, and shares cost $35. Instead of buying only two shares for
$70 and having the extra $30 sitting on the sidelines, you can buy 2.86 shares
and put all that money to work for you immediately. (Head to Chapter 15 for
more on fractional ownership of mutual funds.)
When the next dividend distribution rolls around, you get a fraction of the
dividend based on the fractional share you own. If the quarterly dividend
per share is 50 cents, you earn $1.43 for those 2.86 shares you purchased: 50
cents each for the two whole shares and then 43 cents for the 0.86 shares.
($.50 × 0.86 = $.43).
Dollar cost averaging without lifting a finger
DRIPs are a perfect way to implement a dollar cost averaging strategy —
investing a fixed (or in the case of DRIPs, a semifixed) amount of money regu-
larly over time. (For more about dollar cost averaging, check out Chapter 18.)
You don’t even have to lift a finger because the plan automatically reinvests
your dividends for you, purchasing shares on a regular basis regardless of
current market conditions or share price.
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Chapter 14: Compounding Your Returns with Dividend Reinvestment Plans
Looking at the downside

After ticking off the many benefits of DRIPs, you may be tempted to dump
your broker and deal direct. Not so fast. As with most things in the world of
investing, DRIPs have a flip side — some potential negatives to counterbal-
ance all those positives. Before breaking up with your broker, consider the
potential drawbacks highlighted in the following sections.
Buying on the company’s schedule regardless of price
When you reinvest dividends, you get a bargain because you buy the new
shares right after prices drop due to the dividend payout, giving you more
stock for your dividend dollars. However, you may lose out when the time
comes to make other stock purchases. You have no control over the price
you pay for optional cash purchases, which occur on the company’s sched-
ule, not yours. A company may choose to sell OCP shares once a week, once
a month, or even once a quarter. (It’s always the same day, such as the 15th
of the month.) If the stock happens to hit an all-time high that day, well,
that’s your price.
When you’re buying and selling shares directly through a company, you can’t
issue any of the stop or limit orders I describe in Chapter 19. Of course, if
you’re investing for the long term, this limitation shouldn’t be a huge issue.
Losing liquidity
When you buy and sell stocks through a broker, you can cash out at any time.
Just pick up the phone and tell your broker to sell, or log in to your online
brokerage account and issue a sell order. The trade occurs within minutes,
and in a matter of hours or days you can have the money in your checking or
savings account.
When buying and selling shares directly through a company, you relinquish
that liquidity. You must contact the company or the plan’s transfer agent;
obtain, complete, and submit the necessary forms for closing out the DRIP;
and then wait for your request to be approved. This process can take a few
weeks and may be an available option only once a quarter. You may also
incur some fees for closing the account.

Looking out for fees
Although DRIPs are cheap and commission-free, only about half the DRIPs
are totally fee-free. As money gets tight, more companies try to quietly slip
in fees. As for DSPs, most charge fees, some on every transaction. To pro-
tect yourself, read the prospectus to find out what all the fees in the plan
are and whether any terms seem unreasonable. Some companies charge $5
for an investment of as little as $25 — that’s a 20-percent load on your OCP!
(“Investing at your own pace” earlier in this chapter gives you more informa-
tion on OCPs.)
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Part IV: Checking Out Dividend Investment Vehicles
Check the plan’s prospectus (included with the application packet) for any of
the following fees:
✓ Set up fees to establish the account may run as high as $25.
✓ Termination fees to close the account may run anywhere from $5 to $25.
✓ Commissions (yes, commissions) in DSPs can be in one or more of the
following forms:
• A flat fee between $2 and $25
• A percentage of the amount invested, like a load
• A per-share charge, which can range from a penny to 15 cents a
share
A company may nickel and dime you to the point at which you’re kicking
yourself for not paying your broker $10 for the transaction.
Don’t let fees automatically scare you off. If you really like the stock, a direct
purchase may still be the more cost-effective way to buy shares.
Paying taxes in a DRIP
Even though you don’t receive a check for all those reinvested dividends,
the IRS considers them taxable income. Plan for the following (and check out
Chapter 20 for more on potential tax issues and qualified dividends):

✓ Dividends earned from new shares purchased through a reinvestment
plan the previous quarter are taxed as qualified dividends — as in quali-
fied for a lower tax rate.
✓ Dividends from new shares purchased through an OCP must meet the
holding period requirements to qualify for the lower tax rate.
Keeping detailed records
For all their benefits, DRIPs provide you with one big fat pain in the neck —
recordkeeping. Though you may get a neat printout from the company’s transfer
agent showing all your trades and tallying which dividends and capital gains
qualify for reduced tax rates, you may not. Either way, you alone are responsible
for keeping track of each purchase, including the date, number of shares pur-
chased, and price paid, so you know exactly how much you owe in taxes when
you sell your shares.
Invest in a good spreadsheet program for your computer or purchase a pro-
gram specifically for managing DRIP accounts, as I suggest later in this chapter
in the section “Calculating the Cost Basis of Shares Acquired through DRIPs.”
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Chapter 14: Compounding Your Returns with Dividend Reinvestment Plans
Enrolling in a DRIP
To enroll in a DRIP, you can’t just download an enrollment form, complete
it, and then send your form along with a check to the company you want to
invest in. No, that would be far too easy (and logical). Before you can do any-
thing, you typically must acquire at least one share and then submit a copy
of your share along with an application or enrollment form to request accep-
tance into the program. The following sections step you through the process.
Prior to enrolling in a DRIP, contact the company’s Investor Relations depart-
ment and request information about the program. The company should be
able to supply you with a prospectus that sets out all the details of the plan,

including how to enroll, the minimum number of shares required to open an
account, how often you can make additional investments, how much you can
invest at any one time, how to sell shares, and any fees or other charges you
may incur.
Scoring your first share
Enrolling in a DRIP is like being caught up in a chicken-and-egg dilemma: You
can’t enroll unless you own at least one share of stock in the company, and
you can’t buy shares unless you’re enrolled. This setup is a throwback to
the times when DRIPs were created as a way for employees to invest in their
company. The company would issue shares to the employee, who could then
enroll in the DRIP to have any dividends reinvested. Fortunately, a couple of
options are available for clearing this hurdle:
✓ About half the DRIPs allow you to purchase your first share through the
company DPP.
✓ The rest require you to purchase that first share through a regular
stockbroker, which means opening an account, meeting the broker’s
trading requirements, and making a minimum deposit (usually around
$1,000).
You’ve acquired a share. Great, but you’re still not done. Now you need to
become the shareholder of record (the person holding possession of the
shares according to the company’s records). Even though you usually legally
own the shares when you buy stock, the actual shareholder of record is the
brokerage firm. This designation keeps your shares safe and simplifies the
process of selling shares, lending them out for short sales, or using them to
create ETFs (discussed in Chapter 16.) This arrangement usually makes life
easier for you as well.
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Part IV: Checking Out Dividend Investment Vehicles
To become the shareholder of record, you must take physical delivery of the

shares. Ask the brokerage to send you the actual certificate (and know that
the brokerage may charge a fee for this service).
Obtaining an application
After you get a stock certificate in your name, you’re ready for the next step in
the process — obtaining a copy of the DRIP enrollment application from the
company or its transfer agent. If you don’t have contact information for the
transfer agent, visit the company’s Web site. Poke around the site to find
the Investor Relations area or call the company and ask to speak with some-
one in Investor Relations who may be able to send you the application you
need or at least put you in touch with the transfer agent. Tell the person you
speak with that you need a DRIP application or enrollment form.
Submitting the paperwork
After receiving the DRIP application or enrollment form, complete it, make
a copy of it and the stock certificate, and mail both originals (certified mail
with confirmation request) to the transfer agent as instructed. The transfer
agent processes the paperwork and notifies you when you’ve been approved
to participate in the DRIP (which you will be, assuming you follow the appli-
cation rules).
When you receive notice of approval, contact Investor Relations or the trans-
fer agent and ask when you can start purchasing additional shares. With
some programs, you can begin buying shares immediately. In others, you
must wait until you’ve received your first dividend payment.
Calculating the Cost Basis of Shares
Acquired through DRIPs
One of the main challenges of managing DRIPs is calculating the cost basis
(how much money you pay for your shares) of your investment for tax pur-
poses. As you make additional investments in a company and reinvest your
dividends, you pay a different price for each batch of shares you purchase,
so your cost basis can vary among the shares you own and changes with
each transaction. Unfortunately, you can’t simply use an average cost basis

when calculating the taxes you own on shares you sell, so you need to keep
track of each purchase to know the cost basis of each share.
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Chapter 14: Compounding Your Returns with Dividend Reinvestment Plans
For tax purposes, keep track of the following information:
✓ Total amount of money spent and total number of shares acquired with
each purchase.
✓ Dividends paid, even if they’re reinvested, because dividends are taxed
separately.
✓ Any discounts the company provides when you purchase shares. This
discount qualifies as an additional dividend.
✓ Total amount of money and total number of shares acquired with each
dividend reinvestment.
✓ Any commissions you paid to purchase shares, which can help offset
taxes due on dividend payments.
✓ Total amount of money received when selling shares and the total
number of shares sold.
When selling shares, follow a first in, first out (FIFO) strategy in determining
your capital gains. In other words, the first shares you purchase are the first
shares you sell. This method increases your holding period so that you’re
more likely to qualify for the lower long-term capital gains tax rate. (Flip to
Chapter 20 for details on taxation concerns.)
Keeping track of all the details can be quite a chore. I recommend using a
good personal finance program (or an accountant) to keep detailed records
and perform all the necessary calculations. Most personal finance programs,
including certain versions of Quicken and MS Money, include features for
managing investments. You may also consider using a specialized program
such as DRIP Wizard (www.dripwizard.com).

Squeezing Out More Information
about DRIPs
When you’re ready to get serious about direct investing and reinvesting and
have a craving for information about specific companies that offer these
plans, check out the following resources:
✓ The Moneypaper at www.directinvesting.com (see the nearby sidebar)
✓ The Direct Purchase Plan Clearinghouse at www.enrolldirect.com
✓ Direct Investment at www.wall-street.com/direct.html
✓ DRIP Central at www.dripcentral.com
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Part IV: Checking Out Dividend Investment Vehicles
Because transfer companies commonly manage plans for multiple compa-
nies, they’re also good sources of information about specific plans. Two of
the larger transfer companies are
✓ First Share at www.firstshare.com
✓ One Share at www.oneshare.com
Checking out Moneypaper
The Moneypaper is a company that specializes
in teaching investors about direct investment
plans. A subscription to its monthly financial
newsletter, Moneypaper, costs about $153,
but it offers deals all over the Internet to first-
time subscribers. Your subscription also gives
you access to Moneypaper’s Web site (www.
directinvesting.com), which lists all
the companies that offer DRIPs. Moneypaper
also publishes a bimonthly newsletter called
DirectInvesting, which follows six portfolios,
and an annual book entitled The Moneypaper’s

Guide to Direct Investment Plans.
The Moneypaper offers a unique service to help
investors sign up for DRIPs. Its affiliate broker,
Temper of the Times Investor Services, acts as
your stockbroker. Temper buys one share of the
company for you, registers you immediately as
the shareholder of record, sends the stock cer-
tificate to the transfer agent, signs you up for
the DRIP, and opens the account for you. The
fee for this service ranges from $15 to $50, but
it sure takes the hassles out of getting started.
To keep transaction costs down, Temper gath-
ers orders from investors throughout the month,
closes the offering on the last day of the month,
and orders the stock on the 10th of the follow-
ing month.
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Chapter 15
Diversifying Your Dividends
through Mutual Funds
In This Chapter
▶ Getting up to speed on mutual funds
▶ Understanding the costs of mutual fund investing
▶ Choosing dividend mutual funds
▶ Checking out some dividend mutual funds worth looking at
N
o doubt about it, building and managing a successful dividend stock
portfolio requires a fair amount of expertise and a whole lot of work.
For people who want to follow a dividend stock strategy but don’t have
the time, skill, or interest in building a portfolio, mutual funds and ETFs

(exchange-traded funds) provide a solution.
This chapter describes how mutual funds work and how you can use them to
build a diverse portfolio that takes advantage of the dividend stock strategy.
To focus on ETFs, skip to Chapter 16.
Taking a Refresher Course on Mutual Funds
Mutual funds are investment companies that pool money from many investors to
buy securities and create a portfolio more diverse than most investors would be
able to assemble on their own. Each investor shares in the fund’s profit or loss
according to the number of shares they own. The fund brings in more investing
money by selling shares of the portfolio to the public. As an open-end investment
company (see the nearby sidebar), the mutual fund can sell as many shares as
people want to buy, using the money to purchase additional assets.
The following sections bring you quickly up to speed on the basics of mutual
funds so that you can determine whether you want them to play a role in
your dividend investment strategy.
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Part IV: Checking Out Dividend Investment Vehicles
Examining the pros and
cons of mutual funds
Owning shares of a mutual fund is a trade-off. Mutual funds provide investors
with an easier way to build and manage a diversified portfolio, but investors
relinquish control over which stocks the portfolio holds. That’s the biggie. The
following sections provide a more detailed list of the trade-offs you can expect.
Advantages
Mutual funds offer a host of benefits that essentially boil down to simplicity
and diversity. Mutual funds
✓ Are easy to buy and sell
✓ Offer a diversified portfolio with a minimal investment
Recognizing different types of investment companies

Not all investment companies are created
equal. Before buying shares in an investment
company, recognize the differences among the
three main types of companies:
✓ Open-end investment companies accept
investors at all times and have no restric-
tions on the number of shares they sell.
When investors want their money, they
redeem their shares by selling them back to
the investment company (fund) at the going
rate. The fund then pulls these shares out of
circulation. Mutual funds and ETFs are both
open-end funds.
✓ Closed-end investment companies issue a
fixed number of shares in an initial public
offering (IPO) just as public companies
issue stock. You buy these shares on the
stock exchange from other investors, not
from the fund company.
✓ Unit Investment Trusts are similar to open-
end companies in that they can sell an
unlimited number of shares to meet investor
demand. Unlike open-end funds, however,
UITs have no manager or board of direc-
tors to change the UIT’s components after it
launches. So, the UIT is pretty much a static
portfolio for its limited lifetime. Because no
manager is in charge, a UIT can’t reinvest
the dividends earned in the portfolio.
Remember: Investment companies are highly

regulated entities that must register with the
SEC. They’re organized under the Investment
Company Act of 1940, better known as the 1940
Act. Hedge funds are private, unregulated
investment pools.
Open-end and closed-end funds fall into the cat-
egory of managed investment companies; UITs
are unmanaged. In a managed fund, the manager
can adjust the portfolio, but the unmanaged UIT
is a static portfolio. Another difference is that
managed funds come with a higher price tag to
cover compensation for their managers. For more
about the costs of investing specifically through
mutual funds, check out “A Necessary Evil:
Paying Someone to Manage Your Mutual Fund
Investments” later in this chapter.
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Chapter 15: Diversifying Your Dividends through Mutual Funds
✓ Are run by a professional portfolio manager who does all the research
and decides which securities to buy
✓ Work well with the dollar cost averaging strategy (discussed later in this
chapter and Chapter 18)
✓ Require little work from investors
✓ Are regulated by the SEC
✓ Reinvest dividends
✓ Keep track of all the bookkeeping involved
✓ Allow for redemptions over the phone
✓ Permit the purchase of fractional shares
A fractional share is a part of a share. If you plan to invest $100 a month to buy

shares of a favorite stock selling for $75 a share, you can only buy one share
because stocks sell in whole units. You then have $25 sitting around until you
come up with another $50. However, if you invest with a mutual fund, the fund
invests the entire $100. If one share of the mutual fund sells for $75, the fund
sells you 1
1
⁄3 shares of the fund.
Disadvantages
Many of the disadvantages of mutual funds are simply the flip side of the
advantages — you willingly relinquish control over which equities are
included in the portfolio because you don’t have the time, energy, or inclina-
tion to do the research yourself. However, before you invest in a mutual fund,
be aware of the following drawbacks:
✓ Mutual funds charge management fees.
✓ All taxes are passed on to and paid by the shareholders.
✓ Some charge big commissions.
✓ Shares don’t trade like stocks — they have only one price during the day.
✓ The actions of other investors in the fund affect the amount of capital
gains taxes you pay.
✓ Mutual funds may incur other costs, such as transaction fees for the
stocks it buys and sells.
Diversifying on the cheap
In Chapter 4, I encourage you to diversify your investments to mitigate your
risks. In other words, don’t put all your golden goose eggs in one basket. One
of the biggest challenges to creating a diverse portfolio is coming up with
enough money to purchase a wide variety of stocks. In addition, paying sales
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Part IV: Checking Out Dividend Investment Vehicles
commissions on all those transactions, tracking so many different stocks,

and handling the bookkeeping related to them can cost additional time and
money and make your head spin.
The solution? Mutual funds, which offer instant diversification — and you
may even save commission.
Suppose you have only $2,000 to invest. One option is to purchase 80 shares of
a small pharmaceutical company at 25 bucks a pop. Unfortunately, this option
leaves you with a very concentrated portfolio. If the company’s blockbuster
drug fails to earn FDA approval, you stand to lose a good chunk of your invest-
ment. Another option is to purchase 10 shares of 20 different companies for
$10 apiece. This strategy gives you some diversity, but the transaction fees
take a bite out of that $2,000. A third option is to purchase $2,000 worth of
shares in a mutual fund with 500 different stocks in its portfolio. Option three
gives you a far more diversified portfolio than the other two options, without
the added cost of commissions (though you likely pay management fees). Even
with a management fee, this route is still usually less than paying commissions.
Investment companies have become the main savings vehicle for most
Americans because they provide a quick and easy way to build and maintain a
diversified portfolio with a minimal investment.
Reaping the benefits of
dollar cost averaging
Dollar cost averaging is a method of systematically investing in anything over
a long time period to achieve a reasonable average price for the asset. Mutual
funds are great vehicles for following a dollar cost averaging strategy for a
couple of reasons:
✓ You can buy a little at a time without having to pay a broker for every
purchase.
✓ You can buy fractional shares. In a no-load fund (where you pay no com-
mission), the ability to buy fractional shares means every single dollar
you invest goes into the fund and goes to work immediately instead of
sitting in cash waiting for enough to buy a full share.

For more about dollar cost averaging, check out Chapter 18.
Understanding how funds pay dividends
Funds are required to distribute any income in excess of their expenses. If
the dividend yield is 1 percent of the fund’s assets, and the expense ratio
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Chapter 15: Diversifying Your Dividends through Mutual Funds
(operating expenses) is 1 percent of the fund’s assets, the fund uses the divi-
dend to pay the expenses, and investors receive no income. On the other hand,
if the dividend yield is 3 percent of the fund’s assets, the fund uses 1 percent to
pay the expenses and then distributes the remaining 2 percent as dividends. If
the mutual fund is focused on producing income, it will pay a dividend.
Mutual funds receive dividends much the same way as individual investors do.
The companies whose shares the fund holds mail checks to the fund for the
dividend amount. At the end of either every month or every fiscal quarter, the
fund adds up all the dividends received from its holdings and divides by the
total number of shares to determine the amount of dividends per fund share.
If the fund pays out too much “income,” some of it can be classified as a return
on capital, which falls under capital gains for tax purposes. See “Getting stuck
paying taxes” later in this chapter for more about how returns on mutual fund
investments are taxed.
A Necessary Evil: Paying Someone to
Manage Your Mutual Fund Investments
When you invest in a mutual fund, you’re hiring a professional — the indi-
vidual running the fund — to manage your investments. Unfortunately, this
person doesn’t work for free. Managing a diversified portfolio that earns rea-
sonable returns requires some expertise, time, and effort — all of which you
pay for either in fees or commissions.
Some fund managers earn their keep, and many don’t; all charge fees that can
put a serious dent in the money you have available to invest, and they may

perform no better than a standard S&P 500 Index fund that charges next to
nothing. When investing in mutual funds, you really need to look at the costs
to maximize the net return on your investment. In the following sections, I
explain key factors to consider.
You can never guarantee the returns your fund will produce; however, you can
always know what the fees will be. Your goal is to find a fund that produces
the most consistent, and hopefully largest, return for the smallest amount of
expenses. (Be aware that annual reports from mutual funds typically show the
performance of the fund prior to deducting expenses and loads.)
Avoid funds with high expense ratios and loads. These costs can significantly
reduce your capital gains.
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Part IV: Checking Out Dividend Investment Vehicles
Analyzing a fund’s management style
Choosing a mutual fund is often a matter of choosing a management style,
investment theme, or even a specific fund manager. All mutual funds follow
an investing theme, such as buying the stocks of large U.S. companies or the
bonds of emerging market economies. Some funds and their managers are
very proactive in managing the portfolio — they may buy and sell shares
daily to maximize the funds’ returns. Others are more passive — building a
solid portfolio and adjusting its holdings only occasionally, if at all.
In actively managed funds the manager has the freedom to buy and sell what-
ever stock or bond she wants, whenever she wants, as long as she stays
within the investing theme. Almost every mutual fund that follows a dividend-
based or income-focused strategy is actively managed, but many don’t
charge a load (see the following section).
With a passively managed fund, the manager receives not just a theme but typi-
cally also an index to track, such as the S&P 500 Index or the Russell 2000 Index.
He doesn’t have the freedom to buy and sell whatever stocks he wants — he’s

locked into the index. Because the portfolio must perform in line with the index,
he buys only the index components or a close approximation. Index funds are
classic examples of passively managed mutual funds.
Accounting for expense ratios
Every fund is required to state its expense ratio or annual operating expenses.
The expense ratio breaks down into three parts: management fees, 12b-1
costs, and other expenses.
✓ Management fees: Managers of active funds must hire research staffs to
scope out new investments on a continual basis. They also need to keep
on top of all market developments to buy and sell securities at the best
time to maximize profits. On top of that, the managers need to manage
all the other functions that a mutual fund performs, including account-
ing, record keeping, administration, and distribution, to name a few.
Management fees for passively managed funds are significantly lower than
management fees for actively managed funds because managers of pas-
sive funds don’t have the added expenses of research or stock selection.
✓ 12b-1 fees: This special marketing fee (named after a section of the 1940
Act) pays for promotion and advertising of the fund. Some people think
it’s a hidden commission, but it basically goes to pay brokers to keep
selling these funds. The fee is typically 0.25 percent, but can go as high
as 1 percent.
✓ Operating expenses: This all-encompassing category covers all the other
costs necessary to run the fund, paying for the fund’s administrator, cus-
todian, transfer agent, accountant, index provider, and distributor.
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Chapter 15: Diversifying Your Dividends through Mutual Funds
The average expense ratio for an actively managed fund is about 1.3 percent
of the fund’s total assets, and the management fees typically account for the
lion’s share of that figure. The nice thing about paying a percentage rather

than a set fee is that the fund manager’s interests are more aligned with
yours. If your assets increase in value, she makes more money. If your assets
decrease in value, she makes less money. Paying a management fee isn’t nec-
essarily a bad thing as long as the return you receive justifies the fees.
Paying for the privilege with loads
Because mutual funds don’t trade on the stock exchange, brokers can’t
charge a typical commission, so they charge a special commission called a
load, which is another cost on top of the expense ratio. There are three differ-
ent kinds of loads: front-end load, back-end load, and no load.
✓ Front-end load: The front-end load is a percentage of your investment taken
off the top and paid to the broker at the front end of the investment — the
moment you buy shares. For instance, if you buy $100 worth of shares in a
fund with a 5-percent load, you pay the broker $5 and invest $95 in the fund.
You immediately invest less than you wanted to, which decreases your
returns going forward. Typically, the shares that charge a front-end load are
called Class A shares.
✓ Back-end load: In the back-end load, the broker takes his percentage
when you sell your shares rather than when you buy them. If you sell
$1,000 worth of fund shares, the fund with a 5-percent back-end load
pays the broker $50 and leaves you with $950. Because the object is
to have more money coming out of the fund than going in, the broker
Should I hire a financial advisor?
You meet two kinds of mutual fund investors:
those who use a financial advisor and those
who don’t. If you’re buying and selling individ-
ual dividend stocks on your own, consulting a
financial advisor can be beneficial, especially
when you’re first starting out. If you’re simply
buying shares in a mutual fund, hiring a finan-
cial advisor may only add another expense.

By reading this chapter, you should have the
knowledge you need to research and choose
mutual funds that meet your investment needs.
Pick a mutual fund with a good manager and
you already have a financial guru on your side.
Financial advisors who give advice on how to
steer through the financial waters work under
many titles. They can be called stockbrokers,
certified financial planners (CFP), or registered
investment advisors (RIA). Each one has differ-
ent characteristics. The best choice is usually
a CFP or RIA who takes a percentage of your
assets to run your portfolio for you. Much like
the fund manager who takes a percentage of
the funds assets, this arrangement aligns the
investment advisor’s interest to yours. When
you make money, he makes money, so it gives
him incentive to perform well for you.
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Part IV: Checking Out Dividend Investment Vehicles
stands to make more with a back-load fund than with a front-load fund.
However, the percentage of a back-end load gets smaller every year until
it disappears five to ten years after the investment, so if you’re in the
fund for the very long term, you can avoid paying a back-end load when
you sell. Class B shares typically charge a back-end load.
✓ No load: No-load funds charge no load when you buy or sell your shares.
Because you research the fund and fill out the forms to purchase it, you
essentially pay yourself the broker’s load, which, of course, you invest
into the fund. Invest $1,000, and all of that money goes toward the pur-

chase of shares. When you sell, you keep all the money, except for any
taxes you owe on your gains. To maximize your profits, I recommend
you buy only no-load funds.
The load goes to the financial advisor or stockbroker who sells you the fund,
not the actual mutual fund or its managers.
Many funds with loads also sell their funds through 401(k) retirement plans
as Class C shares. Because a 401(k) plan is a closed system with limited
choices, the fund companies don’t charge investors a load to invest within
the 401(k). However, they do typically charge a higher expense ratio.
Because mutual funds’ annual reports often show performance without
accounting for load and expense deductions, a no-load fund with a small
expense ratio may actually provide a bigger return on your investment than a
fund with a high load and expense ratio that performs better.
You can sometimes buy a loaded fund without paying a load if you join a
mutual fund supermarket at a company like Charles Schwab.
If you use a financial advisor, make sure you’re hiring a fiduciary — someone
legally responsible for making investments in your best interests. A stockbro-
ker isn’t required to be a fiduciary. He needs to make appropriate investments
for your risk level, but he doesn’t have to present you with the most affordable
choice. If two similar funds are available and one pays him a 5-percent load, the
broker can sell you the one that costs you more and earns him more money.
For more information on hiring a financial advisor check out Chapter 19.
Investing in Dividend-Focused
Mutual Funds
Mutual funds abound, and many of them focus more on capital appreciation
than on dividends and income, so you have to be selective. In the follow-
ing sections, I explain how to dig up information on mutual funds, identify
dividend-focused funds, and understand how share prices are calculated. In
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Chapter 15: Diversifying Your Dividends through Mutual Funds
addition, I reveal how mutual funds pay out dividends and detail some of the
tax implications related to these payouts.
Finding information on mutual funds
Most of the Web sites I mention in Chapter 7 offer information on mutual
funds as well as individual companies. For information that’s more focused
on mutual funds, check out the following resources:
✓ Morningstar: This company’s main focus is the evaluation and rating
of mutual funds. The Morningstar Web site (www.morningstar.com)
offers tons of information about performance, fees, and management.
You can often find analyst reports on specific funds.
✓ Lipper: Lipper features an extensive rating system for mutual funds called
the Lipper Leaders. It classifies funds in five areas: total return, consistent
return, preservation of capital, tax efficiency, and expenses. Funds that do
well in the majority of categories are called Lipper Leaders. Go to www.
lipperleaders.com to get to the Lipper Research Center.
✓ Charles Schwab: In addition to selling its own mutual funds, Schwab
runs what it calls a mutual fund supermarket — a platform that allows
you to buy and sell thousands of funds with no loads or transaction fees.
It also offers load funds. In addition, it contains research reports and
screens to help you make more informed decisions.
For additional information about a fund, visit the fund company’s Web site,
where you can usually find gobs of information on the funds, as well as an
online prospectus and application forms.
Spotting dividend-focused mutual funds
When shopping for dividend-focused mutual funds, don’t let the names of
the funds confuse you. Some mutual funds that advertise themselves as
dividend funds hold plenty of growth stocks, and many mutual funds that do
deal exclusively in dividend stocks don’t even have the word dividend in their
name. What’s a dividend investor to do?

The first step is to screen for dividend funds. You can do so using any of
the online tools presented in the preceding section. For example, the Lipper
Leaders Web site enables you to screen for Equity Income Funds.
Another strategy is to look for funds that have any of the following words in
their names: total return, income, or value. Some income funds or blend funds
can also hold bonds, generating income from both stocks and bonds, but
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Part IV: Checking Out Dividend Investment Vehicles
searching for income or value funds should screen out most of the funds that
have nothing to do with dividends.
When researching funds, carefully examine their holdings to determine what
portion of the portfolio is comprised of companies that pay dividends. In the
fund’s prospectus, read its investment objective to determine what kind of
strategy you’re getting into. Look for mutual funds that have a yield greater
than the yield on the S&P 500 Index. Any funds that fall short of this bench-
mark don’t really qualify as dividend funds. Even among funds that focus on
dividends, you can find significant differences in strategy and goals, as exem-
plified in the following list:
✓ Al Frank Dividend Value Fund (VALDX) is an actively-managed fund, but
even though at least 80 percent of the portfolio is made up of dividend-
paying stocks, it seeks total return from capital appreciation, and to a
lesser extent, dividend income.
✓ Aston/River Road Dividend All Cap Value Fund (ARDEX) also invests at
least 80 percent of its capital in dividend-paying stocks, but it focuses on
providing high income through dividends. Long-term capital apprecia-
tion is a secondary concern.
✓ Alpine Dynamic Dividend Fund (ADVDX) focuses on yield much more
than total return. It buys high-yielding stocks, holds onto them long
enough to get the low tax rate, and then sells them for other high-

yielding stocks. This strategy clearly works; as you can see in Table 15-1
at the end of this chapter, this fund posted one of the highest yields
for 2009. However, as I point out in Chapter 8, high-yielding stocks can
sometimes have problems, which can negatively affect total return.
✓ Hennessy Total Return Fund (HDOGX) uses a strategy in which it seeks
a return by allocating 75 percent of the portfolio to the Dogs of the Dow
dividend strategy (which I explain in Chapter 18), and 25 percent of the
portfolio to U.S. Treasury bills.
✓ RNC Genter Dividend Income Fund (GDIIX) eliminates stocks with a yield
below 2.5 percent and tries to capture twice the yield of the S&P 500.
✓ Hodges Equity Income Fund (HDPEX) focuses on total return and long-
term capital appreciation by holding companies with a growth and
income focus that consistently raise their dividend.
As with dividend stocks, you want to look for funds that raise their dividend
distribution, because they invest in companies that consistently increase their
payouts. A fund that has a rising dividend is making good investment choices
from the payout perspective. And just like dividend stocks, you want the divi-
dend fund to have regular payouts and less volatility than growth funds.
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Chapter 15: Diversifying Your Dividends through Mutual Funds
Understanding a fund’s share price
Shares of mutual funds are sold and priced differently than shares of stock.
Shares of stock trade on the stock exchange between investors. The market
drives the price, which can rise or fall throughout the day according to investor
demand. On the other hand, you buy mutual fund shares directly from the fund.
To determine the mutual fund’s share price the fund company first calculates
its net asset value (NAV). When the market closes, the fund obtains the end-
of-day price for every equity held in the portfolio and multiplies each sepa-
rate value by the number of shares the fund holds of that particular equity to

determine its value. It then adds up the values of all equities in the portfolio
and subtracts any liabilities to determine the NAV:
NAV = Total Value of All Equities – Liabilities
If the fund has $30 million in stocks and liabilities of $3 million, the NAV
would be $27 million:
$30 million – $3 million = $27 million
To calculate the share price or NAV per share, the fund divides the NAV by
the total number of shares sold to investors. Continuing from the previous
example, if the fund sold 900,000 shares to investors, the NAV per share
would be $30:
$27 million ÷ 900,000 shares = $30/share
Although you must place an order to buy or sell shares of a mutual fund when
the stock market is open, you don’t know what price you will pay. That’s
because the fund needs the closing price of every equity before it can calcu-
late the NAV, and it can’t get that until after the market’s 4 p.m. close.
Reinvesting mutual fund dividends
When you first invest in a mutual fund that holds shares in companies that
pay dividends, you need to specify what you want to do with the dividends.
Typically, you have three choices — leave the cash in the account, receive
the dividend as a check, or reinvest the dividend and buy new shares at the
current NAV:
✓ Leave the cash in an account: If you choose to leave the cash in the
account, it just sits there until you tell the fund manager what to do with
it — buy more shares of the same fund, buy shares of another fund in
the same fund family, or withdraw the cash. In some cases, the money
earns interest.
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